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Tuesday, July 8, 2014

Taking risks without killing yourself

Risks is always associated with investing and business. People view the stock market as risky and also starting a business as risky. These people may often be your parents or even your colleagues and your friends.

Most young people like risks while older people prefer to avoid risk and go for stability. Young people may like to drive recklessly and speed on the road thinking it is fun. Young people may speculate in stocks trying to make a quick buck. They may also want to start a business.

Risks cannot be avoided and there's a saying that without risk, you won't be successful. Stepping out of your comfort zone is taking risk. But here, i'm not talking about this kind of risk that will propel you upwards. I'm talking about the risks which will kill you either emotionally, financially and hopefully not physically.

The risk that kills"You have got to keep trying, and if it doesn’t work, you always can revert back to what you were doing before". - Jack Ma.
The above phrase is written by Jack Ma who founded the popular internet company: Alibaba Group. He's one of the billionaires in China. His words are an inspiration to whoever who wants to be successful like how he has done it but if used wrongly, you can be in deep trouble.

Most people know starting a business is risky. You may end up losing money and then you really have to revert back to what you were doing before. In fact, most businesses fail before they succeed and thus you have to keep trying. But, if you take on too much risk the first time, you may not even have a second chance to try. Let me explain further.

Let's say 2 young persons wants to start 2 separate businesses. Let's call them Dick and Harry. Dick wants to start his business which requires a capital of $100,000. However, Dick only has $10,000 in his bank account so he borrows from friends, relatives and strangers. These strangers can be banks, financial institutions or even loan sharks. Dick manages to get the $90,000 and starts his business even though he has no prior experience.

Harry on the other hand wants to start a business which requires a capital of $30,000. Harry already has the $30,000 in his bank account so he has no problems coming out with the money. Harry starts his business also with no prior experiences.

Both businesses fail and they were forced to close it down. Dick loses the $10,000 which he has initially and is another $90,000 in debt. He has no choice but to go back to his 9am-6pm job which earns him $3000 a month. Harry is more lucky. He loses the $30,000 which he has and does not have any debt. He goes back to his 9-6 job and earns the same $3000 a month.

In 1 years time, Harry manages to save $20,000 and starts another business with 2 other partners. However, in the same one year, Dick only repaid $20,000 debt and is still $70,000 in debt. He wants to start another business but has no capital. He tries to borrow from his family but they did not lend him. He turned to his friends but they did not trusted him. He cannot get any loans from banks as he has a bad credit report. Dick continues working for the next few years just to repay his debt.

In the story above, both businesses failed but one is able to try a second time while the other cannot. The situation for the latter one may have been worse such that he may fall into depression, lose his confidence and may even commit suicide. This is the risk that kills.

Leverage increases risk
Leverage is using money which you do not have. It is the most common cause of bankruptcy. Leverage can increase your potential for making money but will also magnify your potential of losses. In the investing world, these can be derivatives such as Options contracts, Futures contracts and also CFDs. The popular Forex trading also uses leverage. By using these leveraged instruments, always know the risk that you're taking. If you trade too big and can't control your stop losses, then it's indeed very risky.

In business, leverage is simply using borrowed money to do business. If you borrow too much and the business fails, then you're in deep trouble. Instead of borrowing money to start a business, try forming a partnership to chalk up the required capital. In this way, you're not the only one taking the risk entirely.

Avoid the risk that kills
To be successful, you need to take risks. But, learn to take calculated risks. To finish a race, you have to stay in the race. If halfway you're forced to leave the race, then you have no chance at all. As long as you are still in the race, you can fall and stand up again and carry on. You will still finish the race. Remember the story of the tortoise and the hare in a race which you probably heard in school? The tortoise won the race even though it was much slower than the hare. The hare was faster but decided to take a nap halfway. It's like a person who thinks he's fast and forgets to manage risk. Sometimes, slow and steady wins the race.

Most times, we need to take calculated risk in the form of leverage. Leveraging can be a good tool if used wisely, as most of us would probabl have used when we purchase a large sum of investment such as property.

Yes, leveragr can be a good tool but over leveraging can be disastrous. For Singapore's HDB, we can only use 30% of our gross income to pay for housing loans. In a sense, the government is trying to manage risk for us. 60% seems to be the maximum leverage so that we do not kill ourselves when a financial crisis comes.

Yes, to be rich and successful, we must plan carefully and do our homework. Doing so will mitigate the risk. After all, no generals will win a battle without strategies. Always remember that generals always fight the last battle. Check out my blog SG Wealth Builder for more insights.

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